This memo is produced to present the finding of a financial analysis on Company G, examining the performance in 2012, comparing it to 2011, examining the areas of strength and weakness, and identifying relevant trends. The general financial performance of the firm will be considered and measured against the industry averages using a vertical ratio analysis. This will be followed by a general horizontal trend analysis.

Ratios

Current ratio

The current ratio is designed to measure the liquidity of the firm, meaning it indicates the ability of a firm to pay their current liabilities out of their current assets. The current liabilities audits which are due within 12 months, and current assets are assets which are expected to last less than 12 months. The ratio indicates the amount of times the current assets will cover the current liability. For example, a current ratio of 2 means there are twice as many current assets compared to current liabilities. While a low ratio can be indicative of liquidity problems, a high ratio may also indicate the company as to many unused current assets, and is facing high opportunity cost. The ideal level often cited for traditional organizations is usually 1.5, as there is a sufficient amount of assets to cover the liabilities. The ratio is calculated by dividing the current assets by the current liabilities.

The current ratio for company G. during 2012 is 1.78; this means that the company has 1.78 times the level of current liabilities in current assets. This is slightly lower than 2011 when it was 1.86, and remains relatively similar. It is lower than the highest quartile of 3.1, the middle band with 2.1, but it is higher than the lower quartile of 1.4. A ratio of 1.78 appears to indicate good cash flow management, as the company is well placed to meet its current liabilities, but is not holding excessive surplus of current assets, which are usually assets that are not productive for the company. The ratio indicates that this is a strength of the company, indicating the good cash flow management.

Acid test ratio

The acid test ratio is similar to the current ratio, as it measures the liquidity of the company and ability to pay its current debts out of its current assets. However, if a firm has to raise cash quickly, not all of the current assess may be liquidated at the true values, for example, a quick sale of inventory may need to take place at a reduced sale price. The acid test provides a harsher measure for the payment of debts excluding that the current assets where the value may be compromised in a quick sales. The calculation for this is cash, short-term investments, and accounts receivable, which are then divided by the current liabilities. Therefore, the acid test, which may also be referred to as the quick ratio, measures the liquidity of the company without including all the current assets. Ratios near to 1 are considered to be the most appropriate level.

The acid test ratio for company G. is 0.42, meaning that without the inventory the company can only meet 42% of its current liabilities. Looking at the industry quartiles, the highest is 1.6, and the lowest is 0.6. In 2011 company G. had an acid test ratio of 0.64, so there is a fall. The decreased to 0.42 may be seen with some concern, especially as it is below the lower quartile boundary, placing this is the industry's bottom quartile. With the position in the bottom quartile, and the falling acid test ratio, this is a weakness.

Inventory turnover

The inventory turnover is a ratio which expresses the number of times the total inventory the company sold in the course of the year. An inventory turnover of 12 will mean that the inventorying is sold 12 times over in the year. For most firms a fast inventory turnover is preferable, this would result in a lower level of working capital tied up in inventories, and would indicate efficiency within the organization. The ratio for this report is calculated by dividing the net sales by the average inventory for that year. Higher ratios are deemed to be better. The actual turnover rate will depend on many factors, including the type of products that are sold.

As company G. has an inventory turnover of 5.3, which means the inventories being turned over only 5.3 times per year in 2012, this is a decrease in performance compared to 2011, where it was 6.1. This is also poor in the context of the industry; the top industry quartile is 13, with the middle quartile boundary being 10.2, and a lower quartile being 8.3. Thos places Company G. In the bottom quartile. The inventory may therefore be seen as a weakness, because the level of performance declining and when benchmarking against the industry the firm is in the bottom quartile.

Accounts receivable turnover

The accounts receivable turnover is an indicator of the efficiency and effectiveness that the company outstanding money which is owed to it. The ratio indicates how many times the accounts receivables are turned over in the year, for example a receivables of six would indicate that the accounts receivables will be fully turned over six times in a year. This may also be used to calculate the average time taken to pay.

The calculation takes the total credit sales, and dividing by the accounts receivable. The total credit sales for company G. are calculated at 60% of all sales, so total credit sales will be 60% of the total net sales. Higher ratios are deemed to be better, as this indicates amounts outstanding are collected more rapidly, which in turn indicates a faster and more efficient cash flow cycle.

The accounts receivable turnover for 2012 is 31.3, indicating that the accounts receivable were turned over 31.3 times in 2012. This is a slight decline on 2011 which 32.2, which shows a slight slowdown, which may indicate cause for concern. When looking at the company in the context of the industry, the upper quartile is 35.2, middle 33.5 and lower is 31.4, this placed the firm in the bottom quartile. This is showing the same pattern as the last few ratios, 2012 shows a decline in performance while the bench marking against the industry indicates low performance with the firm in the bottom quartile. This is also a weakness area.

Days sales in receivables

The days sales in receivables is the ratio that shows how many days worth of sales are outstanding as receivables at any point in time. The day's sales in receivables are calculated in two stages. Firstly, the average credit sales per day need to be calculated, this is 60% of the net sales divided by 365. This is then used in a subsequent calculation, where the average net accounts receivable is divided by the level of one days credit sales. This is a ratio where a lower level is better; indicating that any point in time a lower proportion of sales is outstanding as debt. This will reflect the accounts receivable turnover.

The day's sales in receivables outstanding in 2012 are 11.7, which is a slight increase on 11.1 seen in 2011, which is also a decrease in performance. The better performing firms, which are at the lower quartile, have 11.3 or fewer days outstanding, with the mean quartile boundary being 13.5. However, this may also be seen as a weakness as the performance is declining.

Debt ratio

The debt ratio is a solvency ratio looking at the financial structure of the firm, indicating the proportion of debt to assets, expressed as a percentage. It also indicates the ability of the firm to meet its long-term liabilities, as it shows the total liabilities against the total assets. The ideal level for this may vary; conservative approaches indicate that lower values are better as there is a lower level of debt within organization which means lower risk. However, where there are low levels of debt, it may also be argued that the firm is not taking advantage of the available opportunities by failing to borrow to grow. The level of debt can also impact on the cost of equity to the firm, as higher rates indicating higher risk may also increase the cost of equity with the risk premium.

The debt ratio is calculated by taking the total liabilities and dividing them by the total assets. The debt ratio in 2012 for company G. is 29.73%, which is slightly higher than 2011 level of 28.34. This appears to be a strength, as it indicates the firm highly solvent, in addition it is better than many other similar firms, the best firms, at the lower quartile have debt ratios of 30% or less, so the firm is in the top quartile. This is a…
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